Think an HSA Is Just for Healthcare Expenses? Here's Why You're Wrong
Key Points
HSAs offer numerous tax benefits for savers.
Nonmedical HSA withdrawals can be subject to penalties.
You have a lot more flexibility with your account once you turn 65.
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If you have access to a health savings account (HSA), you've probably heard that it's one of the best ways to save for medical expenses. And the reason is simple: HSAs offer tax advantages that are difficult to find elsewhere. Contributions are tax-free, gains are tax-free, and withdrawals are tax-free when used for qualifying medical expenses.
Sure, you'll find these perks in different retirement accounts. Traditional IRAs and 401(k)s give you tax-free contributions. Roth IRAs and 401(k)s give you tax-free withdrawals. But if you want all of these benefits packaged into a single account, HSAs fit the bill.
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There's a catch, though. If you withdraw HSA funds for anything other than qualified medical expenses, you'll generally owe ordinary income taxes on the withdrawal plus a hefty 20% penalty.
That restriction might make you rethink an HSA. But here's why it shouldn't.
Your HSA becomes much more flexible at age 65
While it's true that nonmedical HSA withdrawals can result in a whopping penalty, that only holds true before you turn 65. Once you're 65 or older, you can use your HSA balance for any expense without incurring a penalty. For this reason, it pays to keep funding an HSA and growing your balance.
Now, if you take a nonmedical HSA withdrawal at age 65 or later, you'll be taxed on it. But that simply puts it in the same category as a withdrawal from a traditional IRA or 401(k).
That's why having as large a balance as possible in retirement makes sense. You can tap your HSA for medical expenses and avoid taxes on your withdrawals. But if you realize you're unlikely to spend your entire balance on medical costs, you can use your HSA as a backup IRA or 401(k).
It pays to know the rules
HSAs are an extremely valuable savings tool, so if your health insurance plan is compatible with one, it pays to take advantage of it. But it's equally important to read up on HSA rules so you can make the most of your account.
You should also know that because HSAs allow your money to grow tax-free, a smart bet is to fund one each year you're eligible -- but reserve that money for retirement and pay for near-term healthcare bills another way. That gives your money more time to grow. And if you stick to that plan, you may find yourself sitting on a generous HSA balance in time for retirement.
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